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July 19 — A recent discussion draft from the OECD attempts to determine when a permanent establishment
might bring in returns that exceed what would be achieved through transfer pricing
due to variations in the allocation of risk, an ex-OECD official said.

The draft, released July 4, doesn't create new language, but rather provides examples
of how to apply the authorized OECD approach on attributing profit to a permanent
establishment—a taxable branch of a foreign entity—that has been created under new
standards arising from the Organization for Economic Cooperation and Development's
sweeping project to combat tax avoidance (25 Transfer Pricing Report 345, 7/14/16).

The July 4 draft represents one of the few items of unfinished business from the Organization
for Economic Cooperation and Development's project to combat tax base erosion and
profit shifting, on which most of the work was completed in October 2015.

It describes how the principles in Article 9 of the OECD's Model Tax Convention, which
governs transfer pricing between related entities, affect the analysis outlined in
Article 7, which governs the allocation of profits to a PE.

Andrew Hickman, who recently left his position as the OECD's head of transfer pricing,
said the two treaty articles don't work the same way.

“If you want to tell us that Article 9 is the same as Article 7, then we'd be very
interested,” said Hickman, who was with the organization when it issued the latest
AOA guidance. “My view is that Article 9 is not the same as Article 7. I think you
will get different results in certain circumstances, and that's what we want you to
concentrate on.”

Hickman spoke from the audience during a panel discussion at a transfer pricing conference
sponsored by the National Association for Business Economics in Washington on July
19.

Examples on Risk

He and the panelists discussed Example 2 and Example 4 of the discussion draft, both
of which involve a subsidiary acting as an agent and selling inventory on behalf of
the primary company. The subsidiary's activities include approving sales and managing
customer credit.

In Example 4, both the primary and subsidiary companies are involved in decisions
about how to extend customer credit—a sharing of risk that, the guidance states, should
result in a sharing of possible profits. The guidance also says that sharing may extend
beyond what would be determined through a transfer pricing analysis between the related
parties.

“It's a difficult example to construct,” Hickman said. “In an Article 9 analysis,
we do not share risk in accordance with control. There is a contract; we respect the
contract.” Under Article 9, he said, contractually the risk is with the primary company.

“They do exercise control; the risk stays there,” Hickman said. However, he asked,
“is there a difference under an Article 7 analysis, where you do share the risk, in
accordance with the significant people functions?”

The former OECD official encouraged taxpayers to consider the principles and think
strategically about how the profit attribution rules could work.

“I would encourage you to think about the strategy of the examples and your strategic
response. Don't get bogged down in the numbers,” he said. “What are the principles
here?”

The OECD is accepting comments on the draft until Sept. 5.

To contact the reporter on this story: Alex M. Parker in Washington at
aparker@bna.com

To contact the editor responsible for this story: Molly Moses at
mmoses@bna.com

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